June 18, 2018

June 18, 2018

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Will Your Family-Owned LLC Be Required to Pay the Fair Value of a Withdrawing Member’s Interest?

Family-owned businesses that are organized as limited liability companies typically reflect the terms of the company’s governance, along with the members’ financial rights and obligations, in a written operating agreement. The terms of the operating agreement often specifically include what, if any, payments a member is entitled to if he or she withdraws as a member of the LLC before the LLC dissolves.  For example, the operating agreement may limit the right to payment of a withdrawing member to the return of any balance in his or her capital account.  An operating agreement may even provide that a member is entitled to no payment whatsoever upon withdrawal.  In any case, agreed-upon provisions concerning payments upon withdrawal will reflect the members’ expectations from the outset.  Such provisions can also protect the LLC from having to make large and unplanned payments upon a member’s unilateral decision to withdraw at a point in time when the LLC may not have the funds to pay such a withdrawal distribution.

The Court began its decision by noting:  “This case requires the court to value and divide a family farming business.”

In the absence of any provision in an operating agreement addressing a withdrawing member’s right to payment, the terms of the LLC Act for the state of formation will control. A recent decision from a United States District Court for the Western District of Wisconsin serves as a reminder that the default LLC Act provisions for distributions can result in litigation over withdrawal payments, which could then lead to an order for the immediate payment of distributions to a withdrawing member.  In Leifker v. Leifker Grain, LLC, the Court began its decision, after a trial, by noting:  “This case requires the court to value and divide a family farming business.”  Robert and Rita Leifker had formed a number of LLCs to own and operate various aspects of their business of growing and selling corn and soybeans.  Two of those entities, Leifker Farms, LLC and Leifker Grain, LLC were managed by their son Jamie, who, along with his wife Catari, also held a 45% membership interest in those entities.

As of 2012, Jamie was running the business in consultation with Robert. Catari handled the company’s books.  Rita previously had little to do with the farm operations but, upon her retirement from another job, Rita asked to become more involved with the management of the LLCs.  When Jamie and Catari resisted Rita’s requests for access to the companies’ books, Rita and Robert filed suit to gain access to the books.  Rita and Robert then removed Jamie as co-manager of Leifker Farms, LLC.  While Jamie and Catari had no right to withdraw as members from Leifker Farms, they did have the right to withdraw from Leifker Grain, which they exercised.

Jamie and Catari then filed suit against Robert, Rita and Leifker Grain, seeking an award of the fair value of their 45% membership interest in that LLC. The operating agreement for Leifker Grain did not contain any provision limiting or otherwise addressing a withdrawing member’s right to payment upon withdrawal.  Thus, the Wisconsin LLC Act controlled.  Under the Wisconsin Act, “if not otherwise provided in an operating agreement, within a reasonable time after dissociation [withdrawal], the dissociating member is entitled to receive a distribution in complete redemption of the fair value of the member’s interest in the limited liability company as of the date of dissociation.”  (While it is important to understand the provisions of the LLC Act for the particular state of an LLC’s formation, it is noteworthy that many states’ LLC Acts, including Massachusetts, contain provisions with nearly identical language to Wisconsin’s Act.)  In the absence of any operating agreement provision on point, the Court determined that Jamie and Catari were entitled to the fair value of their interest as of the date of their withdrawal, pursuant to the Wisconsin Act.

For their part, Robert and Rita agreed that Jamie and Catari were entitled to the fair value of their interest. They also agreed with the valuation method of Jamie and Catari’s expert witness, who presented a net asset approach in calculating the total value of Leifker Grain. Robert and Rita were left only to dispute certain items the expert included on the company’s balance sheet and the resulting calculation of total value.  The Court made two relatively modest adjustments to the balance sheet calculations, as argued by Robert and Rita, but otherwise adopted Jamie and Catari’s expert’s calculations. The Court found that the total value of Leifker Grain was $3,325,882 and that the fair value of Jamie and Catari’s 45% interest was $1,496,646.  The Court then entered judgment in their favor in that amount.

According to the Court’s decision, Robert and Rita also had liquidated Leifker Grain upon Jamie and Catari’s withdrawal and received the liquidation value at some point before the judgment entered. Under the Wisconsin LLC Act, a withdrawn member who is entitled to a distribution is treated as a creditor who can enforce his or her claim against the LLC and, if the LLC’s assets have been liquidated and distributed, against any members to whom the assets have been distributed in liquidation.  Thus, Robert and Rita were individually liable as members for the entire amount of the judgment in Jamie and Catari’s favor, even if the liquidation proceeds were less than the fair value of the Jamie and Catari’s LLC interest as of the date of their withdrawal.

The decision should remind members of family-owned LLCs of the need to address the rights and obligations concerning payments to a withdrawing member in a written operating agreement.

The decision in the Leifker case should remind members of family-owned LLCs of the need to address the rights and obligations concerning any payments to a withdrawing member in a written operating agreement.  Specifically, in states with LLC Acts that permit member withdrawal, the members should consider adding language to the operating agreement that eliminates a member’s right to withdraw and to receive fair value for their interests.  Without such an agreement, the default provisions of the applicable state’s LLC Act will apply.  Depending on the language of the applicable LLC Act, a withdrawing member’s demand for payment upon withdrawal may leave the LLC and its remaining members with an unexpected and perhaps impracticable financial obligation. At a minimum, lack of clarity as to any rights to payment upon withdrawal, or the method of calculating such a payment, could lead to litigation over what, if any, payments are due.

© Copyright 2018 Murtha Cullina


About this Author

Michael P. Connolly, Murtha Cullina, Shareholder Agreements Lawyer, Business Valuations Attorney

Michael Connolly is a partner in the firm's Litigation Department. He represents owners and managers of family-owned businesses and closely-held businesses in connection with disputes between business owners under LLC operating agreements, shareholder agreements, and partnership agreements; claims against directors and officers concerning company management and operations; and other internal disputes concerning business valuations, corporate distributions, and access to company information.

Mr. Connolly also has an active business litigation...